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Why Do Firms Smooth Earnings?

  • Anand Mohan Goel

    (University of Michigan)

We explain why a firm may smooth reported earnings. Greater earnings volatility leads to a bigger informational advantage for informed investors over uninformed investors. If sufficiently many current shareholders are uninformed and may need to trade in the future for liquidity reasons, an increase in the volatility of reported earnings will magnify these shareholders' trading losses. They will, therefore, want the manager to smooth reported earnings as much as possible. Empirical implications are drawn out that link earnings smoothing to managerial compensation contracts, uncertainty about the volatility of earnings, and ownership structure.

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Article provided by University of Chicago Press in its journal Journal of Business.

Volume (Year): 76 (2003)
Issue (Month): 1 (January)
Pages: 151-192

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Handle: RePEc:ucp:jnlbus:v:76:y:2003:i:1:p:151-192
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  1. DeFond, Mark L. & Park, Chul W., 1997. "Smoothing income in anticipation of future earnings," Journal of Accounting and Economics, Elsevier, vol. 23(2), pages 115-139, July.
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  9. Franklin Allen & Douglas Gale, 1999. "Diversity of Opinion and Financing of New Technologies," Center for Financial Institutions Working Papers 98-30, Wharton School Center for Financial Institutions, University of Pennsylvania.
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